Ирина Эланс

Автор который поможет с любыми образовательными и учебными заданиями

American depository receipts. Theory and practice

MINISTRY OF EDUCATION AND SCIENCE OF THE RUSSIAN FEDERATION

PLEKHANOV RUSSIAN ACADEMY OF ECONOMICS

INTERNATIONAL BUSINESS SCHOOL

Coursework

“American depository receipts. Theory and practice”

Student: Sologub Asia

Group: 5403

Supervisor: Sokolnikova I.V.

Moscow 2012

table of contents

Introduction 3

What is a DR 4

History and Reasons for using ADRs 5

Benefits of ADR’s 7

Benefits to a Company 7

Benefits to an Investor 7

ADRs vs. Stocks 9

ADRs' Special Risks 10

Advantages of ADRs 11

Disadvantages of ADRs 11

Types of DRs 12

Practice: how are DR’s traded 14

Buying and Selling DRs 16

Procedure of issue of ADR 18

Cancellation 19

Trading - (Pricing) 19

Equity Offerings 20

Conclusion 21

Endnotes 22

Bibliography 23

Introduction

Nowadays more and more companies all over the world are looking forward to attract international investors. Going public at a stock exchange is one of the most attractive and cost efficient ways of getting financial inflows. Hence there are companies that prefer local, state stock exchanges, large majority rushes for international stock exchanges, such as NYSE and LSE.

A long the costly procedure of preparing for the IPO company’s owner should analyze all the possible consequences of this step, define goals and opportunities, evaluate its assets, choose a stock exchange, where at his opinion, company’s shares will have the best demand.

The American Depositary Receipt (ADR) plays an important part in the process of going public. ADRs represent shares of a foreign stock owned and issued by an underwriter bank. The foreign shares are usually held in custody overseas, but the certificates trade in the U.S. Through this system, a large number of foreign-based companies are actively traded on one of the three major equity markets (the NYSE, AMEX or Nasdaq, LSE or MSE).

To this end ADR is a way of going public at an international level, which allows a significant shift in company’s development.

What is a DR

Globalization is the dissolution of barriers to trade and investments, and the tendency of the world's businesses to integrate customs and values. Globalization is making it increasingly easy to travel, correspond and even invest in other countries.

Investing money in a home country's stock market is relatively simple. One may call a broker or login to an online account and place a buy or sell order. Investing in a company that is listed on a foreign exchange is much more difficult.

However, now there is an easy way around this through ADRs. More than 2,000 foreign companies provide this option for investors interested in buying shares.

An American Depository Receipt, or ADR, is a security issued by a U.S. depository bank to domestic buyers as a substitute for direct ownership of stock in foreign companies. An ADR can represent one or more shares, or a fraction of a share, of a non-U.S. company. Individual shares of a foreign corporation represented by an ADR are called American Depositary Shares (ADSs).

An ADR is a convenient way for companies whose stock is listed on a foreign exchange to cross-list their stock in the United States and make their stock available for purchase by U.S. investors, as these receipts can be traded on U.S. exchanges.

Some ADRs are traded on major stock exchanges such as the NDAQ and the NYSE, which require these foreign companies to conform to many of the same reporting and accounting standards as U.S. companies. Other ADRs are traded on over-the-counter exchanges that impose fewer listing requirements.

Stock dividends and similar adjustments to the underlying shares are paid in cash or ADR dividends by the bank.

History and Reasons for using ADRs

American Depositary Receipts have been introduced to the financial markets as early as April 29, 1927, when the investment bank J. P. Morgan launched the first-ever ADR program for the UK’s Selfridges Provincial Stores Limited (now known as Selfridges plc.), a famous British retailer. Its creation was a response to a law passed in Britain, which prohibited British companies from registering shares overseas without a British-based transfer agent, and thus UK shares were not allowed physically to leave the UK.2 The ADR was listed on the New York Curb Exchange (predecessor to the American Stock Exchange.)

The regulation of ADR changed its form in 1955, when the U.S. Securities and Exchange Commission (SEC) established the From S-12, necessary to register all depositary receipt programs. The Form S-12 was replaced by Form F-6 later, but the principles remained the same till today.

Crucial novelties brought the new regulatory framework introduced by the SEC in 1985, which led to emergence of range of DR instruments, as we know it nowadays. Then the three different ADR programs were created, the Level I, II and III ADRs. This change was one of the impulses for revival of activity on the otherwise stagnant ADR market.

In April 1990, a new instrument, referred to as Rule 144A was adopted, which gave rise to private placement depositary receipts, which were available only to qualified institutional buyers (QIBs). This type of DR programs gained its popularity quickly and it is very frequently employed today.

The ADRs were originally constructed solely for the needs of American investors, who wanted to invest easily in non-US companies. After they had become popular in the United States, they extended gradually to other parts of the world (in the form of GDR, EDR or IDR). The greatest development of DRs has been recorded since 1989.

In December 1990, Citibank introduced the first Global Depositary Receipt. Samsung Corporation, a Korean trading company, wanted to raise equity capital in the United States through a private placement, but also had a strong European investor base that it wanted to include in the offering. The GDRs allowed Samsung to raise capital in the US and Europe through one security issued simultaneously into both markets.

In 1993, Swedish LM Ericsson raised capital through a rights offering in which ADDs were offered to both holders of ordinary shares and DR holders. The Ericsson ADDs represented subordinated debentures that are convertible into ordinary shares or DRs. German Daimler Benz AG became the first European Company to establish a Singapore depositary receipts program (SDRs) in May 1994.

Those shares, or receipts, can then be traded on regular stock markets almost as though they were shares held directly in the foreign company itself, only the arrangement is better for US investors. Since ADRs are traded in US dollars and are securities that originate within the United States, they carry none of the cross-border fees or other hassles that might ensue if an investor from Peoria were to try to buy stock directly in a South Korean steel mill. The worst most investors have to worry about are small fees, often a few pennies per ADR per year, charged by the depository institution to cover their costs of offering the service.

Thus, in a sense, US investors gain access to the world through ADRs without having to leave the comfort of their own living rooms.

Benefits of ADR’s

The increasing demand for Depositary Receipts is driven by the desire of individual and institutional investors to diversify their portfolios, reduce risk and invest internationally in the most efficient manner possible. While most investors recognize the benefits of global diversification, they also understand the challenges presented when investing directly in local trading markets. These obstacles can include inefficient trade settlements, uncertain custody services and costly currency conversions. Depositary Receipts overcome many of the inherent operational and custodial hurdles of international investing. In fact, cost benefits and conveniences may be realized through Depositary Receipt investing, thus allowing those who invest internationally to achieve the benefits of global diversification without the added expense and complexities of investing directly in the local trading markets.

Benefits to a Company

Currently, there are over 2,000 Depositary Receipt programs for companies from over 70 countries. The establishment of a Depositary Receipt program offers numerous advantages to non-U.S. companies. The primary reasons to establish a Depositary Receipt program can be divided into two broad considerations: capital and commercial.

Advantages may include:

Expanded market share through broadened and more diversified investor exposure with potentially greater liquidity, which may increase or stabilize the share price.
Enhanced visibility and image for the company's products, services and financial instruments in a marketplace outside its home country.
Flexible mechanism for raising capital and a vehicle or currency for mergers and acquisitions.
Enables employees of U.S. subsidiaries of non-U.S. companies to invest more easily in the parent company.

Benefits to an Investor

Increasingly, investors aim to diversify their portfolios internationally. However, obstacles such as undependable settlements, costly currency conversions, unreliable custody services, poor information flow, unfamiliar market practices, confusing tax conventions and internal investment policy may discourage institutions and private investors from venturing outside their local market.

Depositary Receipt advantages may include:

Quotation in U.S. dollars and payment of dividends or interest in U.S. dollars.
Diversification without many of the obstacles that mutual funds, pension funds and other institutions may have in purchasing and holding securities outside of their local market.
Elimination of global custodian safekeeping charges, potentially saving Depositary Receipt investors up to 10 to 40 basis points annually.
Familiar trade, clearance and settlement procedures.
Competitive U.S. dollar/foreign exchange rate conversions for dividends and other cash distributions.
Ability to acquire the underlying securities directly upon cancellation.

ADRs vs. Stocks

Like normal stocks, ADRs tend to trade at levels that track the financial health of their underlying companies. Still, there are important differences between an ADR and a directly held stock.

For example, there are different flavors of ADRs, each of which carries a different level of reporting responsibility - in other words transparency in reporting their financial health - to US regulators and investors.

Unsponsored shares: These offer the lowest level of entry into the American market. Unsponsored shares trade only on over-the-counter markets - not on the major US stock exchanges - and bear no responsibility to report to US regulatory agencies. They are rarely issued today.

Level I: These shares can also only be traded on over-the-counter markets, but they are generally issued through only one US agent - their depositary "sponsor." Regulatory reporting requirements are still minimal. Quarterly or annual reports are not required. Even if such reports are issued, they are not required to adhere to US standards of generally accepted accounting principles, or GAAP, and the companies can post their results in a foreign currency.

Level II: Companies that want to sell ADRs to US investors at this level have to register with the Securities and Exchange Commission and file an annual report that complies with GAAP standards. This is the lowest level of shares that can be listed on a US stock exchange.

Level III: This is the gold standard of ADR ratings. It allows foreign companies to issue shares directly into the US, rather than simply allowing the indirect purchase of already created shares. In exchange, the company is required to file annual reports that comply with GAAP standards, typically something known as a form 20-F (compared to the regular 10-K filing by companies in the United States). And it is required to share any news that it distributes within its home country to US investors as well.

ADRs' Special Risks

Of course, even though they trade in US dollars and can, at least on the surface, closely look and feel of American stocks, ADRs come with their own set of special considerations to keep in mind.

Currency risk: If the value of the US dollar rises against the value of the company's home currency, a good deal of the company's intrinsic profits might be wiped out in translation. Conversely, if the US dollar weakens against the company's home currency, any profits it makes will be enhanced for a US owner. For more information on how this could damage or inflate results, read the danger of investing in international bonds.

Political risk: ADR status does not insulate a company's stock from the inherent risk of its home country's political stability. Revolution, nationalization, currency collapse or other potential disasters may be greater risk factors in other parts of the world than in the US, and those risks will be clearly translated through any ADR that originates in an affected nation.

Inflation risk: Countries around the globe may be more, or less, prone to inflation than the US economy is at any given time. Those with higher inflation rates may find it more difficult to post profits to an US owner, regardless of the company's underlying health.

In other words, ADRs are just what they seem: a representation of a foreign stock, rather than an actual holding in the company. Because of all of the considerations listed above, an ADR of a foreign company in the US. May be traded a little ahead or a little behind the price the company commands in its own currency in its own home base. But it's safe to say that buying an ADR is the closest an American investor can come to participating directly in the rest of the world's economy.

Advantages of ADRs

Flexibility to list on national exchange in the US
Ability to rise capital
Increasing of awareness of a company
Diversify portfolio
Reducing financial costs on taxes and international transactions
Trade is clear and settle in US Dollar

Disadvantages of ADRs

ADRs have some important limitations and drawbacks.

Limited selection: Not all foreign companies are available as ADRs. For example, Japan's Toyota Motor has an ADR, but Germany's BMW does not.
Liquidity: Plenty of companies have ADR programs available, but some may be very thinly traded.
Exchange rate risk: While ADRs are priced in dollars, for sake of convenience, investment is still exposed to fluctuations in the value of foreign currencies.
Because ADRs are like stocks, it is necessary to buy enough of them to ensure adequate diversification. So if investment capital is not enough to spread around, say 25 to 30 ADRs (or more), it is hard to create a truly diversified portfolio.

Types of DRs

American Depositary Receipts (ADR)

Companies have a choice of four types of Depositary Receipt facilities: unsponsored and three levels of sponsored Depositary Receipts. Unsponsored Depositary Receipts are issued by one or more depositaries in response to market demand, but without a formal agreement with the company. Today, unsponsored Depositary Receipts are considered obsolete and, under most circumstances, are no longer established due to lack of control over the facility and its hidden costs. Sponsored Depositary Receipts are issued by one depositary appointed by the company under a Deposit Agreement or service contract. Sponsored Depositary Receipts offer control over the facility, the flexibility to list on a national exchange in the U.S. and the ability to raise capital.

Practice: how are DR’s traded

Description

A Depositary Receipt is a negotiable security which represents the underlying securities (generally equity shares) of a non-U.S. company. Depositary Receipts facilitate U.S. investor purchases of non-U.S. securities and allow non-U.S. companies to have their stock trade in the United States by reducing or eliminating settlement delays, high transaction costs, and other potential inconveniences associated with international securities trading. Depositary Receipts are treated in the same manner as other U.S. securities for clearance, settlement, transfer, and ownership purposes. Depositary Receipts can also represent debt securities or preferred stock.

The Depositary Receipt is issued by a U.S. depositary bank, such as The Bank of New York, when the underlying shares are deposited in a local custodian bank, usually by a broker who has purchased the shares in the open market. Once issued, these certificates may be freely traded in the U.S. over-the-counter market or, upon compliance with U.S. SEC regulations, on a national stock exchange. When the Depositary Receipt holder sells, the Depositary Receipt can either be sold to another U.S. investor or it can be canceled and the underlying shares can be sold to a non-U.S. investor. In the latter case, the Depositary Receipt certificate would be surrendered and the shares held with the local custodian bank would be released back into the home market and sold to a broker there. Additionally, the Depositary Receipt holder would be able to request delivery of the actual shares at any time. The Depositary Receipt certificate states the responsibilities of the depositary bank with respect to actions such as payment of dividends, voting at shareholder meetings, and handling of rights offerings.

Depositary Receipts (DRs) in American or Global form (ADRs and GDRs, respectively) are used to facilitate cross-border trading and to raise capital in global equity offerings or for mergers and acquisitions to U.S. and non-U.S. investors.

Demand for Depositary Receipts

The demand by investors for Depositary Receipts has been growing between 30 to 40 percent annually, driven in large part by the increasing desire of retail and institutional investors to diversify their portfolios globally. Many of these investors typically do not, or cannot for various reasons, invest directly outside of the U.S. and, as a result, utilize Depositary Receipts as a means to diversify their portfolios. Many investors who do have the capabilities to invest outside the U.S. may prefer to utilize Depositary Receipts because of the convenience, enhanced liquidity and cost effectiveness Depositary Receipts offer as compared to purchasing and safekeeping ordinary shares in the home country. In many cases, a Depositary Receipt investment can save an investor up to 10-40 basis points annually as compared to all of the costs associated with trading and holding ordinary shares outside the United States.

Issuance

Depositary Receipts are issued or created when investors decide to invest in a non-U.S. company and contact their brokers to make a purchase. These brokers, through their international offices or through a local broker in the company's home market, purchase the underlying ordinary shares and request that the shares be delivered to the depositary bank's custodian in that country. The broker who initiated the transaction will convert the U.S. dollars received from the investor into the corresponding foreign currency and pay the local broker for the shares purchased. On the same day that the shares are delivered to the custodian bank, the custodian notifies the depositary bank. Upon such notification, Depositary Receipts are issued and delivered to the initiating broker, who then delivers the Depositary Receipts evidencing the shares to the investor. Broker can also obtain Depositary Receipts by purchasing existing Depositary Receipts, which is not a new issuance.

Transfer - (Intra-Market Trading)

Once Depositary Receipts are issued, they are tradable in the United States and like other U.S. securities, they can be freely sold to other investors. Depositary Receipts may be sold to subsequent U.S. investors by simply transferring them from the existing Depositary Receipt holder (seller) to another Depositary Receipt holder (buyer); this is known as an intra-market transaction. An intra-market transaction is settled in the same manner as any other U.S. security purchase: in U.S. dollars on the third business day after the trade date and typically through The Depository Trust Company (DTC). Intra-market trading accounts for approximately 95 percent of all Depositary Receipt trading in the market today. Accordingly, the most important role of a depositary bank is that of Stock Transfer Agent and Registrar. It is therefore critical that the depositary bank maintain sophisticated stock transfer systems and operating capabilities.

Buying and Selling DRs

If an investor wishes to purchase shares in a foreign company, he can either buy the foreign shares in the local market through a broker in that country or, providing the foreign company in question has a DR program, the investor can request his broker to buy DRs. The broker may either purchase existing DRs or, if none are available, he may arrange for a depositary bank (e.g. Deutsche Bank) to issue new ones. The process for issuing new DRs is very simple. The investor's broker contacts a broker in the issuing company's home market and acquires shares in that company. These shares are then deposited with the depositary bank's local custodian. Upon confirmation that the custodian has received the shares, the depositary issues the requisite number of DRs to the investor via the broker.

In some exceptional cases there may be restrictions on the issuance of new DRs under existing programs (e.g. Indian GDR programs) because of local regulations. DRs can be sold in DR form, in which case they trade and settle like other US or Euro securities. They can also, however, be cancelled. In this case the broker acting on behalf of the owner of the DRs will request the depositary bank to cancel the DRs and release the underlying shares to a domestic broker in the issuing company's home market. The domestic broker will then sell the shares locally and the proceeds will be remitted to the investor who cancelled those DRs.

• DRs certify that a stated number of underlying shares have been deposited with the depositary's custodian in the foreign country.

• DR holders are entitled to all the dividends payable on the underlying foreign shares and, furthermore, to have these paid in the currency in which the DRs are denominated – usually US dollars.

• The DRs may be bought or sold through investors' own brokers, and they clear and settle through the Depository Trust Company (DTC) for ADRs, through Euro clear and Clear stream for EDRs and through all three (and possibly other clearing systems) in the case of GDRs, depending on which markets they access.

• Shareholder information such as annual reports, notices of general meetings and corporate actions, and official news releases are provided by the issuer to the depositary and to the receipt holders, either direct or through the local custodian.

• The investor is thus spared the costs and difficulties often encountered when direct investment is made in local markets, where currency, settlement, and linguistic problems may be compounded by an excessive number of intermediaries.

Procedure of issue of ADR

To find the Depository bank

Depository bank has only right to issue the GDRs. So, it is necessary to find depository bank in USA and other European countries.

Issue the Shares to Depository bank

Shares cannot be issued to foreign investors. But shares are issued to depository bank and depository bank will accept the shares of Indian companies as the custodian of foreign investors.

Deposit the fees

For issuing GDRs, either investors or Company has to deposit the fees for issuing the certificate named global depository receipt.

Issue of GDRs and Record

Depository bank has right to issue one GDR certificate for 2 to 10 shares. The issue of GDRs is for those investors who will pay the amount of shares of companies. After this, it will be assumed that USA or other foreign countries' investors have acquired the shares of companies. Indian company gets money of shares through depository banks. On the other side, foreign investors' name registered and they will get dividend through this bank in USA Dollar. Companies are using same procedure for getting fund through GDRs. This year, an investment company successfully issued shares in the form of Global Depository Receipts (GDRs) to foreign investors. After issuing GDRs, these shares can deal in any foreign stock exchange and GDRs will be one of the security type in stock exchange list of stocks.

Cancellation

When investors want to sell their Depositary Receipts, they notify their broker. The broker can either sell the Depositary Receipts in the U.S. market through an intra-market transaction or sell the shares outside of the U.S., typically into the home market through a cross-border transaction. In cross-border transactions, brokers, either through their international offices or through a local broker in the company's home market, will sell the shares back into the home market. To settle the trade, the U.S. broker will surrender the Depositary Receipt to the depositary bank with instructions to deliver the shares to the buyer in the home market. The depositary bank will cancel the Depositary Receipt and instruct the custodian to release the underlying shares and deliver them to the local broker who purchased the shares. The broker will arrange for the foreign currency to be converted into U.S. dollars for payment to the Depositary Receipt holder.

Trading - (Pricing)

Once Depositary Receipts are issued and there are an adequate number of Depositary Receipts outstanding in the U.S. market (usually three percent to six percent of the company's shares in Depositary Receipt form), a true intra-market trading market emerges. Until this market develops, the majority of Depositary Receipt purchases result in Depositary Receipt issuances upon the deposit of shares. When executing a Depositary Receipt trade, brokers seek to obtain the best price by comparing the Depositary Receipt price in U.S. dollars to the dollar equivalent price of the actual shares in the home market. Brokers will buy or sell in the market that offers them the best price, and they can do so in three ways: by issuing a new Depositary Receipt, transferring an existing Depositary Receipt or canceling a Depositary Receipt. For example, if the price of the actual shares in the home market is $12.28 per share after allowing for foreign currency translation, and the Depositary Receipt is selling for $12.30, the broker will buy shares and issue Depositary Receipts until the price of the ordinary shares increases to $12.30, at which time the broker will simply buy and sell the existing Depositary Receipts that are outstanding in the market. The broker may also be holding an inventory of ordinary shares, in which case the local trading price is irrelevant.

The continuous buying and selling of Depositary Receipts in either market tends to keep the price differential between the local and U.S. markets to a minimum. As a result, about 95 percent of Depositary Receipt trading is done in the form of intra-market trading and does not involve the issuance or cancellation of a Depositary Receipt.

Equity Offerings

When a non-U.S. company completes an offering of new shares, part of which will be sold as Depositary Receipts in the U.S. or international market, the company will deliver the shares to the depositary bank's local custodian at the time of the closing. The depositary bank will then issue the corresponding Depositary Receipts and deliver them to the members of the underwriting syndicate. With this pool of Depositary Receipts, a regular trading market commences where Depositary Receipts can then be issued, transferred or canceled.

Conclusion

Investing in foreign stocks or in a foreign stock market can be a complex and challenging undertaking. However, an American Depositary Receipt (ADR) makes the process much easier for an individual investor. An American Depositary Receipt is a foreign stock issued on an U.S. exchange by an investment bank denominated in U.S. currency.

The main advantage of buying an American Depositary Receipt rather than the foreign stock itself is the ease of the transaction. Many people are more familiar and comfortable investing on the U.S. exchanges. ADRs are a great way to invest abroad without having to convert U.S. dollars to many different currencies. Also, it can be difficult to learn how to purchase shares on a foreign stock exchange as an individual investor. Another advantage offered by an ADR is that if the foreign stock does pay dividends, the investment bank will convert the dividends to U.S. dollars and remit the payment. In addition, if the dividend is subject to foreign tax, the investment bank will withhold the tax.

In conclusion, American Depositary Receipts are a great way to invest in foreign companies. Since the ADRs are issued on U.S. exchanges they are very easy to buy and sell without having to convert currencies. However, even though investing on a U.S. exchange, the foreign company’s profits are usually earned in a different currency. Therefore, if exchange rates may vary, it would hurt the value of ADR. If investing in foreign stocks, ADRs should be part of investment decision.

Endnotes

1. Federal Law of the Russian Federation No. 282-FZ "On Amendments to the Federal Law "On the Securities Market" dated December 30, 2006, amending Federal Law of the Russian Federation No. 39-FZ "On the Securities Market" dated April 22, 1996, as amended.

2. According to the FSFM official website (URL: http://www.fsfm.gov.ru/document.asp?ob_no=8668).

3. Federal Law of the Russian Federation No. 173-FZ "On Currency Regulation and Currency Control" dated December 10, 2003, as amended.

4. Russiallaws.com

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American depository receipts. Theory and practice